Defence Stocks Performance Amid Heightened Tensions

As geopolitical tensions have continued to intensify globally, the defence sector has recently remained notably subdued.

The Growing Conflicts

There are currently two active wars ongoing: Russia's invasion of Ukraine and Israel's operations in Gaza. However, several other nations have seen increased military action recently. The US and UK conducted airstrikes in Yemen against threats to Red Sea shipping, with the former also striking Iranian-backed militants in Iraq in response to attacks originating from Baghdad. Venezuela has threatened action against Guyana, while Ecuador is dealing with a possible coup. Several protracted conflicts have continued for years, including violence in South Sudan, Syria's civil war, and Boko Haram's insurgency in West Africa.

So, there are many reasons for countries to increase military spending. One key rationale is maintaining military strength to counter rising geopolitical instability and the possibility of further escalation of tensions. However, increased defence spending does not always directly result in higher profits for defence companies. Various factors can intervene to impact revenues or shares' price.

For example, Lockheed Martin reported its Q4 earnings on Wednesday. Despite reaching record sales and backlog, the company warned that revenue at this rate was not expected to continue, leading the stock lower. The company said its flagship F-35 program saw sales increase by only 2% last year. On the other hand, General Dynamics reported a record backlog on Wednesday but didn't provide any warnings about sales performance for 2024. Instead, its share price soared to its highest all year.

Overcoming Obstacles

With European budgets constrained by fiscal rules, the US stands out as not having any qualms about spending well into the red. However, politics are interfering, with planned allocations for Ukraine and Israel now stalled in Congress amid a cost-of-living crisis and an election year where votes are paramount.

Questions around arms export markets also arise, with sales threatened by recent Boeing safety concerns. Tanks are yet another issue, as Ukraine experiences a remarkable attrition rate of its German-built Leopard tanks, while General Dynamics' Abrams has not been seen on the front line for reasons that have not been disclosed.

But as the global economy slows, the appetite for costly arms and equipment generating industry profits may be limited despite rising geopolitical risks, especially with talks of a Gaza ceasefire and stalled battlelines in Ukraine potentially concluding the two most recent conflicts stimulating defence stocks. Remaining to be seen is whether de-escalating international tensions could prompt a "reverse bump" for defence sector valuations going forward. In the shorter term,  Northrop Grumman will report later today, with earnings expected at $5.80 despite an increase in sales, lower than Q4 2023 when it reported $7.50 in earnings.

Northrop in Rising Flag

The share price of Northrop Grumman has spiked since the Gaza conflict sparked defence interest, from a low of $415 on October 6 to reaching $496 by the 17th, when it peaked. The bearish price action could be characterised by a rising flag pattern pending the breakout of the upper trendline, and $482 and $486, eventually leading to fresh highs for the year. The measured-move projection sees a rise past $600 from the breakout point. Conversely, losing the support at $455 may keep the trend going for a little longer, ultimately heading towards $440 to reject the lower trendline. If bulls fail to bolster prices there, the likelihood of revisiting the Oct low will increase.

Source: SpreadEx

Key Takeaways

The impact of rising geopolitical tensions and conflicts on defence stocks has been mixed. While increased military spending by countries could benefit defence companies, various factors affect their revenues and share prices. Although some defence companies have reported records, others warned of slower revenue growth going forward. However, US defence spending is also relatively unrestrained compared to constrained European budgets. But on the other hand, issues like arms export controls, safety concerns, and slowing economic growth could limit profits for defence firms unless a de-escalation prompts a "reverse bump" for defence valuations.